Fancy Wall Street types who take helicopters to work and eat caviar smoothies for breakfast have plenty of dough to dabble in the stock market. Meanwhile, there are many investors out there who don't have large sums of cash, but still want to mess around in the market. They can't play the market with their own money, so they purchase shares on margin. This means they take out a loan from a brokerage firm and hope to pay it back when they make that great profit when the stock they bought skyrockets in price.
But where does the brokerage firm get the money to loan out? Answer: from a bank...see, brokerages aren't that different than people. But unlike normal humans, the call money rate a brokerage firm gets for clients' margin accounts is not available to the general public.
So, let's say Too Big to Fail Inc. wants to purchase 50,000 shares of a hot stock priced at $20 per share on their margin account. They promise to pay the money back within 30 days after they have bought and sold the stock. The brokerage firm Margin Me Today does not have that kind of cash available, so they go to a bank, who loans them the money at a call money rate of 5%.
This sounds like a great deal except the call loan rate is recalculated every day and also compounds daily until the loan is repaid or called in by the bank. No deadline is set for repayment, but the bank reserves the right to call in the loan at any time, which could force Too Big to Fail to pay back their margin loan immediately as well. (Gulp!)
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Finance: What is Busted Convertible?14 Views
Finance a la shmoop..what is a busted convertible?
well techno growth forever biotechs swore to its customers that upon death they [Mans head enters into a glass jar]
could sever their heads freeze them and in 40 years they would have technology
to have them reborn into a really cool robot body and yeah kim kardashian model
was a huge huge hit we cannot lie.... The company stocks zoomed to a hundred
dollars a share and management needed cash to open offices in China Latin [Cash travels around the world]
America and Africa but they didn't want to suffer dilution by just selling
equity or part ownership in themselves to the street at least not at the
hundred dollar share price they really just wanted to borrow money [Cash and an IOU note appears on a table]
to fund these new offices because well they thought their stock would easily
get to $250 a share in the next few years
tons of people out there who wanted to you know live forever
you know like fame.....nevermind their bankers were nervous about how
investors would react to just a straight bond which carried 8% interest so
instead they kind of compromised by doing a convertible preferred stock [Men give handshake]
offering they sold preferred stock to the street that carried just 3% interest
but those preferred shares were convertible into common stock at a
hundred seventy five bucks a share so the owners of the preferred would keep [Stock value of biotech company rises]
clipping their three percent coupons until one day the stock hit a hundred
seventy five bucks or better well and then they could participate in the
[Man hits a baseball] upside if the stock really was a homerun but sadly as many things do in shmoop
video....Test came back from the early decapitating trials and well they were
oh so not good legions of zombies began to roam the streets and while consumers [Zombies walking along the streets]
just didn't want to go there they'd rather truly rest in peace so the stock
cratered down to $20 a share where it would sit for all eternity in what is
called a busted convertible and took us a while to get there but we got
there the convertible preferred would pay 3% a year in interest as it always [Preferred stock with 3% interest sticker]
had and a convertible stock is so far below the conversion price of $175 well,
investors assume it will never convert the investment case views
the convert solely as a preferred or kind of like a bond offering against
competitive bond interest rates so yeah that's a busted convertible although so
is this they really never should have given robot Kim K a driver's license [Robot Kim Kardashian beside an upside down, crashed car]
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